Indian capital markets have evolved significantly over the last two decades. The scope and size of the operations have witnessed unprecedented growth over the period. The equity market capitalization of BSE grew from a mere Rs 6.1 lakh crore in 2001-02 to Rs 159 lakh crore in 2019-20. The growth has coincided with a host of technological changes undertaken by the stock exchanges. The most notable technological intervention was the introduction of electronic trading in India. In 1996, Indian stock exchanges shifted from physical trading of securities to electronic trading.
Though the shift was initiated by the Securities and Exchange Board of India, it was facilitated by vital institutions like depositories. Depositories are SEBI-approved institutions that are tasked with the secure storage of securities like shares, debentures and bonds. Depositories extend their storage services to investors through demat accounts. Depositories are like banks and demat accounts are just like bank accounts. The only difference is that demat accounts store securities instead of cash.
A demat account, along with a trading account and a bank account, is a prerequisite to access the stock markets. You can trade in certain types of derivatives without a demat account but will need one if you want to trade in the equity segment. A demat account is one end of the investing spectrum and the bank account the other. The trading account is the interface between the two. You store cash in a bank account and use it to buy securities through the trading account. The securities bought by you are stored in the demat account until you sell it.
Origin: The concept of the dematerialization of shares was firmly established in India by the Depositories Act 1996. The act led to the establishment of depositories in India, which is the fulcrum that supports electronic trading of shares in the country. Depositories are institutions that hold all the securities in the electronic form. Central Depository Services Limited (CDSL) and the National Securities Depository Limited (NSDL) are two depositories operating in India.
Rationale: The primary objective of the Depositories Act was to make transferability of securities free, fast, accurate and secure. The establishment of depositories and the introduction of demat accounts have made trading in securities convenient, cheap and hassle-free. But to avail the benefits of demat account, you will have to dematerialize physical securities, which simply means to convert physical certificates into an electronic form. Several changes in the norms by SEBI has made electronic trading of shares compulsory in India.
Medium: Depositories hold the securities in individual demat accounts, but how do you get access to a demat account? Depository participants provide access to a demat account. Depositories do not directly deal with the investors. Depositories have agents known as depository participants or DP who offer depository services to investors. According to SEBI norms, institutions such as banks and stockbrokers are eligible to act as DP. Investors like you will have to open a demat account through a DP to dematerialize and then trade in securities.
There can be specific instances of the rejection of the dematerialization request.
As the name suggests, re-materialization is the process by which securities held in the electronic form can be reconverted into physical form. To rematerialize, you will have to submit a Remat Request Form or RRF to your DP. On receiving the form, the DP blocks the securities to the extent of the request in the demat account. The form is then forwarded to the depository and the issuer or the registrar. After verification, the company/registrar prints out the physical certificate and sends it to the investor. One of the benefits of a demat account is that it provides ample flexibility to convert and reconvert physical securities. However, as per SEBI norms, you can hold physical certificates but cannot trade with them.
Though the demat account is a result of the dematerialization of shares, there are several aims and objectives of a demat account.
The biggest demat account aim and objective is to ensure the safety of clients’ securities. Before demat accounts were introduced, shares were stored in the physical form, which was susceptible to theft. The electronic storage of securities with highly secure depositories has made theft a thing of the past. Similarly, the era of physical securities was marked with multiple instances of forgeries.
Before the advent of demat accounts, companies used to issue security certificates, which were relatively easy to forge. Demat accounts have eliminated forgeries due to a variety of checks inherent in the system. It is easier to track electronic transactions and movement of electronic shares, which also makes it easier to detect forgeries and frauds.
Along with protection from theft and forgeries, demat accounts also prevent you from losing or misplacing securities. Share certificates were just like other documents, if not kept properly, you could easily lose them. People used to lose or misplace their share certificates before electronic trading. The demat account has made everything electronic, which has put an end to the chances of losing your shares.
Along with the safety of securities, investor convenience is another major aim and objective of the demat account. Earlier, if you had to transfer shares, you would have to send the shares to the company or registrar to get them transferred to your name. It was a tedious, costly and an extremely slow process considering the logistics speed in the country. The process took months to complete and shares would even get lost in transit resulting in a loss for the investor. In contrast, the demat account has made a quick transfer of securities a reality. Currently, stock exchanges take just T+2 days to settle the entire transaction.
Like other activities, the process of changing the address was cumbersome before the introduction of demat accounts. In the past, investors had to fill out an application for changing their address. People with investment in various companies had to inform all the companies separately about the change. One of the demat account aims and objectives is to improve access to the capital markets by improving convenience. Now, you just have to inform the depository participant and they automatically update the address in the records of the companies in your portfolio.
The cost of a transaction automatically reduces if you improve the flow of the money. When shares were traded in the physical form, you had to complete a lot of paperwork and ensure the papers reached their destination on time. This would entail a lot of time cost and actual expenses. The logistics expenses were high and there was an additional cost of losing valuable time. Demat account had made the system efficient and has reduced paperwork and logistics-related costs substantially.
Another cost-benefit of demat accounts is that it made the stamp duty irrelevant. Trading in physical shares meant buying a share transfer stamp and sticking it to the bottom of the certificate. Sometimes, investors had to go to the stock exchange to get the share transfer stamp. Getting share transfer stamps was more difficult and costlier for investors from small towns. Demat account aims and objectives were to reduce the cost of trading and make it convenient for the investors and the elimination of stamp duty has helped in achieving the objective.
A market achieves maximum efficiency only when the smallest investor gets the same opportunity as the biggest. In the era of physical trading of shares, there were a plethora of terms and conditions attached to investing. One of the important conditions was that you could only trade in even lots of shares. It meant that, if you wanted to sell 51 shares of a company, you wouldn’t get a buyer in the market. Since all the calculations and settlements were done manually, trading only in even lots eased the process. One of the biggest benefits of the demat account is that you can easily buy or sell any number of shares without any restrictions.
A demat account is a mandatory requirement for trading in securities in India. However, the demat account is just the front-end which is supported by a depository on the back-end. Depositories facilitate holding of electronic securities and ensure transactions are processed by the book building method. A depository supports the transfer of securities from various investors at the same time. On the front-end, a transaction in the capital markets requires the transfer of securities from the buyer to the seller. But at the back end, the transfer of securities from the holder to the depository takes place.
The depositories maintain demat account with unique numbers for every client to ensure the safety of the transaction. Even the securities held by the client are given unique ISIN numbers to ensure a smooth transfer without any errors. Besides shares, you can also hold mutual fund units, bonds, gold ETFs and other assets in your demat account. In simple words, a demat account is a virtual locker to store a wide variety of electronic assets.
Along with the dematerialisation of securities, there are a host of other benefits of demat account. The security guaranteed by demat accounts has opened several avenues for investors. The holdings in your demat account can help you get access to a variety of financing options from banks. When you avail a loan, the bank has to ensure the security and authenticity of the collateral. With multiple instances of securities frauds, banks used to be wary of taking certificates as collateral. Due to the security and authenticity of ownership offered by demat account, it is easier to use securities as collateral. Demat accounts have also simplified the process of receiving benefits of corporate actions. If a company announces dividend, interest or refunds, the amount automatically shows in the demat account. Similarly, in case of stock split or bonus issue, the status is automatically updated in the demat account.
Demat accounts have enabled simultaneous access through multiple mediums, simplifying the investing journey for many investors. One of the benefits of demat account is that you can trade through a smartphone, tablet or a computer seamlessly without any hassles. Even though the demat account is necessary, it is just a part of a larger mechanism. You should have a trading account and a bank account as well. Bank accounts do not matter much, but you should make an informed decision while choosing the trading account. It is advisable to choose a demat-cum-trading account from a reputed brokerage firm.